The Economics of Delaying Policy Change: An Application to the 1992 CAP Reform

Positive political economy is usually concerned with economic explanations of observed policy choices, while the timing of a policy reform has not gained similar attention. This is somewhat surprising since policy makers most often are free to decide both the design and timing of a policy reform. Drawing on insights from recent developments in the finance literature on investment under uncertainty, here we apply the idea of option value to the analysis of government policy making. Common political-economic explanations of the 1992 CAP reform are that policymakers felt domestic political pressure to make the CAP more efficient, and also international political pressure and to bring the CAP in line with treaty obligations. Although these arguments are sound, they fail to explain why policy-makers did not enact the reform earlier, especially during times of decreasing world market prices prior to 1992. We address this question using the theory of option value, which is the value of being able to wait in decisionmaking. Commonly governments are free to decide when to reform policy. Waiting to reform policy can improve government decisions. For while waiting decision-makers may observe market parameter changes as they occur. (For example, they may obtain better information about changes in world prices.) This reduces their uncertainty about the effects of their decisions. Giving up the option to wait incurs a cost which has to be taken into account in policy decisions. We illustrate the option value concept using a political-economy model of the 1992 CAP reform. We show empirically that if decision-makers had not had the option to wait to reform policy, it would have been more efficient to implement the 1992 CAP reform in the mid 1980s.

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 Record created 2017-04-01, last modified 2017-08-25

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